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15 September, 15:10

You must evaluate a proposal to buy a new milling machine. The base price is $120,000, and shipping and installation costs would add another $15,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $70,000. The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. The machine would require a S6,000 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $46,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.) What is the milling machine's terminal (non-operating) cash flow at the end of year 3?

A. $76,000

B. $54,440

C. $51,500

D. $54,808

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  1. 15 September, 15:28
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    Option (D) is correct.

    Explanation:

    Cost = base price + shipping and installation costs

    = $120,000 + $15,000

    = $135,000

    Depreciation Year 1 = 33% * 135000

    = 44,550

    Depreciation Year 2 = 45% * 135000

    = 60,750

    Depreciation Year 3 = 15% * 135000

    = 20,250

    Accumulated Depreciation on machine at the end of year 3:

    = Depreciation Year 1 + Depreciation Year 2 + Depreciation Year 3

    = 44,550 + 60,750 + 20,250

    = 125,550

    Hence Book Value at the end of year 3 = $135,000 - $125,550

    = $9,450

    Sale Value = $70,000

    Gain on sale of asset = $70000 - $9450

    = $60550

    Tax on gain on sale of asset = 35% * 60550

    = $21,192.5

    Hence, net cash flow from sale of asset = $70,000 - $21,192.5

    = $48,807.5

    Terminal Cash Flow:

    = Net Cash flow from sale of asset + net working capital

    = $48,807.5 + $6,000

    = $54,807.5 or $54,808
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